Jeffrey Jones: Canada’s oil can fill U.S. gap, but at what cost?

Jeffrey Jones: Canada’s oil can fill U.S. gap, but at what cost?

Ugly images of unrest on the streets of Caracas are no reason for Canadian oil producers to cheer, even if their margins improve as a result.

Venezuela is sinking into a chaotic and violent morass as its economy collapses and, in a desperate play for self-preservation, its President cracks down on political opposition.

A once-mighty founding member of the Organization of the Petroleum Exporting Countries (OPEC), Venezuela is struggling with shortages of food and other staples as the downturn in crude prices enters a fourth year. As many as 125 people have been killed in street protests since April.

Now, U.S. President Donald Trump and his officials have raised the possibility of sanctioning the country’s oil exports, which have been in steady long-term decline with the drop in investment in Venezuela’s oil industry.

If that happens, Canada will be called upon to help fill the shortfall. The countries are competitors in the U.S. Gulf Coast region, where refineries are geared to process the heavy oil that both produce in large volume. Prices for Canadian heavy barrels have already climbed sharply to account for such an eventuality.

Western Canadian Select, a cocktail of conventional heavy oil and bitumen from the oil sands, sold on Tuesday for about $10 (U.S.) a barrel less than West Texas Intermediate (WTI), the U.S. benchmark. That’s a razor-thin discount by historical standards. A year ago, the spread was $13.90 a barrel under WTI. In late 2013, it blew out to nearly $40, though WTI was nearly $100 a barrel at the time.

As the situation unfolds, the big question is: How much heavy oil can Canadian producers ship to the Gulf Coast? The answer seems to be: Not all that much more. At least in the near future.

In the past month, shares in some heavy-oil producing companies have edged up as investors weigh the odds of improving margins while Texas refineries start asking around about alternative supplies. The producers had all been squeezed in the industry downturn, and stand to make up some lost cash flow from the tight price spread.

Here’s where things stand. The United States has added Venezuelan President Nicolas Maduro to a growing list of officials facing financial sanctions after a contentious vote allowing him to change how government policies are made and adopted. Critics charge that the victory gives Mr. Maduro’s ruling party virtually unlimited power, and, indeed, at least two opposition leaders have already been arrested in overnight raids.

The country’s energy industry – its main source of revenue – may face sanctions in the form of an embargo on oil into the United States, though that’s not a certainty. U.S. imports from the South American country have fallen to 708,000 barrels a day from 1.2 million barrels a decade ago. By contrast, Canada’s shipments to the United States have doubled to nearly 3.6 million barrels a day in the same period, though most of those barrels go to U.S. Midwest refineries.

Over all, a disruption in Venezuelan supplies in the United States would lift global oil prices. North American prices would climb by the greatest magnitude, said Michael Tran, commodity strategist at Royal Bank of Canada. He points out the Trump administration may be wary of slapping a ban on Venezuelan oil as it could mean a spike in domestic fuel prices, resulting in a hit to the economy just as Mr. Trump trumpets recent gains.

Canada’s crude is easily substituted in the southern U.S. market, hence the perceived opportunity. There are other supplies though, including heavier Saudi Arabian barrels that are handy if needed.

One veteran Calgary-based crude trader says Canadian oil can fill gaps where needed, but he points out that pipeline routes to the U.S. Gulf are chronically full. Rail transport is not currently economical, unless a shipper has long-term capacity, because the price spread between Alberta and the oil hub of Cushing, Okla., is less than the cost of a train ticket. “We are already getting as much Canadian oil south as we can economically,” the trader says.

The situation will undoubtedly benefit TransCanada Corp. as potential shippers consider whether to sign up for capacity on the newly resurrected, 830,000 barrel a day Keystone XL pipeline proposal to the southern United States from Canada.

In the meantime, though, given the market conditions, there is only so much more oil Canada can get to where it might be needed.